Tax-Cap Credits & Local Budgets In 2012

by Larry DeBoer

Professor of Agricultural Economics Purdue University

It’s budget season for Indiana local governments. Our counties, cities, schools and other units will adopt spending plans for 2012 by the end of October. To make a spending plan it helps to know how much money you’ve got to spend. Our new property-tax caps make this a bit tougher.

Under the caps, homeowner tax bills are limited to one percent of the home’s assessed value, other residential property and farmland taxes are limited to two percent, and business property is limited to three percent. The taxpayer gets a credit if a tax bill exceeds the cap. The credit is a part of the tax bill that isn’t paid, so it’s revenue that local government doesn’t collect.

That’s a problem for budgeting. To know how much money will be available to spend, a local government needs to know total tax credits, the part of the levy taxpayers don’t pay. A taxpayer’s credit depends on the sum of taxes paid to the county, city, school and other units. During the budget process each government doesn’t know what the other governments will do. It won’t know how big total tax bills will be, so it won’t know the level of tax-cap credits. Therefore, it can’t know how much propertytax revenue will be received.

An unexpected increase in tax-cap credits can create a budget shortfall, where there’s not enough money to deliver the planned level of services. That happened to many governments in 2011. Statewide, tax cap credits increased by $143 million in 2011. Credits were 7.2 percent of the total levy in 2010 and 9.2 percent in 2011.

We don’t know what will happen to tax cap credits in 2012, but we know the reasons why credits went up in 2011. Let’s look at those reasons, and ask whether they’ll happen again.

The tax reform of 2008 replaced homestead tax credits with homestead assessment deductions. In 2011 the last of the state homestead credits phased out. The credit rate averaged four percent in 2010. The final phase out increased homeowner tax bills in 2011, which made homeowners eligible for more tax credits.

There are no more state homestead credits, so there can’t be another phase out. That means tax-cap credits might not increase as much in 2012.

In 2011 local income-tax distributions fell by 16 percent statewide. In some counties, some of this revenue is used for local property-tax credits, to reduce property-tax bills. With less local income-tax revenue, the propertytax credits were smaller in 2011. That increased tax bills, and made taxpayers eligible for more taxcap credits.

The state budget agency has already announced local incometax distributions for 2012. Almost half the counties will see their distributions frozen at 2011 levels. Statewide, distributions are down only one percent. Without a big income-tax drop, property-tax credits funded with income taxes won’t decrease as much in 2012. Tax-cap credits might not rise as much.

Property assessed values for 2011 taxes were based on selling prices from 2009. The economy hit bottom in 2009, which drove down property prices and reduced new construction. Assessed value in 2011 dropped by one percent statewide. If the tax levy stays the same or increases, a lower assessed value means higher tax rates are needed. Higher tax rates increase tax-cap credits.

Our erratic recovery was underway in 2010 so assessed value might not fall for 2012 taxes. We won’t know until the new assessments are available. But if tax rates don’t rise as much in 2012, tax-cap credits won’t increase as much either.

Tax-cap credits depend mostly on local events. If a local government increases its tax rates, all the overlapping governments could see more tax-cap credit losses. Local governments ought to let one another know about their budget plans, especially if they’re going to increase their tax rates substantially.

But in 2012 there will be no state homestead credit phase out, no big drop in local income-tax distributions, and (perhaps) no big drop in assessed value. These are reasons to think that, statewide, tax-cap credits won’t increase as much in 2012 as they did in 2011.